In the past, dividend investing has been associated with maximising income at the expense of capital performance and total return.
However, the last 15 years have shown that investing in companies that pay high dividends has actually resulted in superior total returns.
As shown in the chart below, the MSCI World High Dividend index underperformed in the dot-com boom, but was resilient when the bubble burst, and through the difficult early 2000s.
High dividend strategy has outperformed
Dividend investing then outperformed in the five years leading up to the financial crisis, but underperformed during the height of the crisis in late 2008.
A closer look at the High Dividend index in 2008 shows that a 30% concentration in bank stocks (which were healthy dividend payers) was the culprit.
Since the beginning of the recovery in 2009, high dividend stocks have continued to outperform – and investor interest in dividend investing has grown steadily.
According to Stephen Thornber, Portfolio Manager, Global Equity Income, at Threadneedle Investments, it is also important to note that the outperformance of high dividend investing is not just a result of investors seeking yield in a low-yield environment. If that were true, rising interest rates between 2005 and 2008 would have resulted in underperformance, which did not occur.
“In our view there are persistent reasons why high dividend investing has outperformed, and can continue to outperform. We believe that behavioural biases, including illusion of control and over-confidence, can result in management overestimating prospects and the likely return on capital from projects,” Mr Thornber said.
“Company management teams that are accountable for high and regular dividend distributions, on the other hand, are forced to be more disciplined when deciding how to deploy capital. As a result, the company is less likely to undertake value destroying projects, and will be more efficient with its capital investments,” Mr Thornber said.
“Much has been written about the conflicts of interests between company management and shareholders. In recent years, closer ties between pay and shareholder returns have been implemented by many companies to reduce this problem. We believe that companies that pay high dividends are less affected by this problem than others and that commitment to a regular and high dividend sets a healthy management culture. In our experience, it is also companies with high insider ownership that typically take a progressive approach to dividends and ultimately deliver the most consistent returns to shareholders over time,” he said.
